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March 2013

Consolidated Financial Statements vs. Companies Bill

By Dolphy D’Souza, Chartered Accountant
Reading Time 5 mins
Currently, listing agreement mandates listed companies to prepare Consolidated Financial Statements (CFS). Neither the existing Companies Act nor AS 21 requires companies to prepare CFS. Under the Companies Bill, 2012 (Bill) all companies, including unlisted companies and private companies that have a subsidiary will need to prepare CFS.
Unlike IAS 27, the Bill does not exempt an intermediate unlisted parent company from preparing CFS. Under IAS 27 an unlisted intermediate parent is exempt from preparing CFS if and only if:
a)the parent is itself a wholly-owned subsidiary, or is a partially-owned subsidiary of another entity and its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting CFS;

b)the parent’s debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets);

c)the parent did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market; and
d)the ultimate or any intermediate parent of the parent produces CFS available for public use that comply with International Financial Reporting Standards.
Preparation of CFS at each intermediate parent level is likely to increase compliance cost. The Ministry of Corporate Affairs may look into the matter, and provide an exemption on the above similar lines. The said exemption may be incorporated in the rules.
For all companies, CFS should comply with notified Accounting Standards (AS) . Notified AS currently means the Indian GAAP. In the future, it may include Ind-AS for specified entities. This will impact companies that are currently preparing CFS according to IFRS, based on option given in the listing agreement. These companies will have to mandatorily prepare Indian GAAP CFS (Ind-AS in the future), and may choose to continue preparing IFRS CFS on a voluntary basis or stop preparing the same. The Ministry of Corporate Affairs may look into the matter and allow companies to continue preparing CFS using IASB IFRS instead of Indian GAAP or Ind-AS.

There seems to be some confusion with respect to associates and joint ventures. The explanation, to the section 129 of the Bill states that “the word subsidiary includes associate company and joint venture.” Apparently, the following two views seem possible:

(i)a company needs to consolidate associates and joint ventures in accordance with the notified AS using equity/proportionate consolidation method. In other words, CFS is prepared only when the group has at least one subsidiary para

(ii)a company needs to apply equity method/ proportionate consolidation to its associates and joint ventures even if it does not have any subsidiary. In other words, CFS will be prepared when the company has an associate or joint venture, even though it does not have any subsidiary.
The first view seems more aligned to the requirements of notified AS and the current practice. The second view can be supported if the intention of the lawmaker was to require a company to apply equity method/proportionate consolidation method to its associates and joint ventures even if it does not have any subsidiary. ICAI and MCA should provide clarification on this issue. It would be appropriate if the clarification maintains status quo with current requirement, which is essentially view (i).

The definition of control, subsidiary and significant influence as provided in the Bill and the accounting standards are quite different. If the companies to be consolidated under the Bill and the accounting standards are different, because of the differences in the definition, it would create a lot of confusion and difficulty. A comparison of the definitions is given in the Table.

Apparently, the definition of “control” given in the Bill is broader than the notion of “control” envisaged in the definition of the term “subsidiary.” In accordance with definition of “subsidiary,” only board control and control over share capital is considered. However, the definition of the “control”, suggests that a company may control other company through other mechanism also, say, management rights or voting agreements. Further, the definition of “subsidiary”, refers to control over more than one-half of the total share capital, without differ-entiating between voting and non -voting shares. This could lead to a situation where a company is a subsidiary under AS-21, but on which the parent has no control as defined in the Bill. Consider a simple example of a company, which has a share capital of Rs. 100, comprising 40% equity with voting rights held by A and 60% preference shares with no voting rights, held by B. In accordance with AS, A would consolidate the company but in accordance with the Bill, B would consolidate the company. The Bill seems to provide an unacceptable response, where the lender rather than the equity holder would consolidate the company.
There seems to be similar confusion with respect to associates. In accordance with the explanation in the Bill, the term “significant influence” means control over 20% of business decisions. Control over business decisions is an indicator of subsidiary, rather than associate. It appears that the definition in the Bill “controls 20% of business decisions” is wrongly described. The right way to describe it would have been “has significant influence over all critical business decisions”, and “significant influence is evidenced by 20% voting power, representation on the board, or through other means.” The other issue is that the 20% under the standard works as an indicative threshold. In other words, even a lesser percentage may give significant influence and a higher percentage need not necessarily give significant influence. However, under the Bill the 20% requirement works like a rule, rather than a rebuttable presumption.

To resolve all these anomalies, the MCA may clarify that the definitions in the Bill are relevant for legal/ regulatory purposes. For accounting purposes including preparation of CFS, definitions according to the notified AS should be used.

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